How to Read a Financial Report, 10th Edition

14INTEREST EXPENSE, ACCRUED LIABILITIES, AND LOANS PAYABLE

In this chapter I’m going to explain the connections between loans payable, interest expense, and accrued liabilities. Loans payable and accrued liabilities are in the balance sheet, while interest expense is in the income statement. The reason I have grouped these three accounts together is that they are closely associated with each other. Please refer to Exhibit 14.1 in coordination while digesting these three concepts:

1. Loans payable: To start, when a company obtains formal loans from a bank or other financial lending institution, the terms of the loans are agreed to, which include the cost of the loan (i.e., interest rate), when and how the loans will be repaid, and a slew of other terms and conditions. Loans usually come in one of two forms, either short-term working capital lines of credit (e.g., a consumer credit card that provides borrowing capacity up to a set limit) or long-term fixed loans (e.g., a 30-year home mortgage that is repaid over a 30-year period with set monthly payments). When a loan balance is due and payable in less than one year, it is reflected as a short-term loan payable in the balance sheet. When a loan balance is due and payable after one year, it is usually reflected as a long-term loan payable. In our example company, you will notice that both short-term and long-term loans are outstanding. This is not uncommon for businesses, as companies often use both short-term and long-term loans ...